The Institute for Fiscal Studies (IFS) recently released a report looking at when people should save for retirement.
It uses a simple economic model that assumes individuals will generally want to maintain a standard of living throughout their lifetimes, and then factors in life events (such as earnings growth, repaying student loans, and having children) to show when pension saving would best fit it.
For those of us in the pension industry, the conclusions may at first seem counterintuitive: the modelling suggests that most people should do most of their pension saving later in life.
Where earnings increase over time, the modelling shows individuals spending all or most of their earnings in the earlier years and then increasing saving later on without affecting their standard of living.
For those with children, it shows saving rates dipping for the years the children are assumed to be at home, and increasing significantly thereafter.
Where student loans are a factor, the modelling shows that saving rates should increase once the loan has been repaid. In all cases, the majority of saving happens towards the end of working life.
Perhaps you’re like me, and after reading that immediately thought of all the times you’ve heard and read the opposite message: that we should be encouraging people to save as much as possible, as early as possible.
I should highlight that the report does not argue against individuals saving early. In fact, it emphasises that the models used are a simple ‘stylised representation of reality’, and when you consider the uncertainty inherent in real life (for example, the fact that earnings are not guaranteed to increase smoothly over time), there are good arguments for people not to leave all of their pension saving until later in life.
It also considers employer contributions, and the fact that it won’t normally be advisable to miss out on matched employer contributions by putting off saving until a later point.
The IFS also looked at how much (and when) people are actually saving in reality, which is where things really get interesting. The IFS showed that savings rates do not increase with age to the extent that the modelling would suggest is required.
These findings suggest that, in terms of encouraging people to save adequately for retirement, we shouldn’t necessarily focus so much on encouraging people to save as much as possible, as early as possible.
In the various discussions about reforming contribution tax relief over the years, there have been several suggestions to give larger incentives to younger savers and/or lower earners. One criticism of such proposals has always been that such incentives can’t help individuals who simply don’t have the disposable income to save; or where saving would cause a detriment elsewhere, such as increasing debt. That argument would seem to be reflected here.
Instead, the IFS report suggests we should focus on encouraging and incentivising people to increase their pension savings at key points when they’re in a position to do so, such as when student loans are repaid or when children leave home.
The paper suggests that future auto-enrolment policies might be created with these considerations in mind. I suppose that leaves the question of how to incentivise savers who don’t have those life events: arguably such individuals should be in a position to save more (and more consistently) anyway, but would they in reality?
One particularly interesting suggestion around incentives related to earnings, and whether we should offer additional incentives for people to save more as their earnings increase. This isn’t wholly dissimilar to the idea of higher rate taxpayers receiving more tax relief under the current system, which is frequently cited as being unfair.
Does the modelling suggest that this isn’t necessarily the case? Perhaps the link to tax rates isn’t the best solution – there’s a strong argument to say that after a certain level of earnings there’s no need to incentivise saving.
However, the report does show that there’s a lot of sense in encouraging higher levels of saving, once people are in a position to save more without having to make other sacrifices.
If nothing else, it’s another demonstration that there’s not necessarily an easy solution when it comes to encouraging adequate pension saving.
Jessica List is pension technical manager at Curtis Banks